Π-CAPM: The Classical CAPM with Probability Weighting and Skewed Assets

Joost Driessen, Sebastian Ebert and Joren Koëter

The Review of Financial Studies, 2025, vol. 38, issue 12, 3497-3541

Abstract: We propose a new asset pricing model that generalizes the mean-variance framework by including probability weighting, specifically the overweighting of rare, high-impact events. Our model—the -CAPM—generates several new predictions: (i) skewness has a positive price effect, amplified by volatility; (ii) the price effect of volatility is negative for left-skewed assets but positive for right-skewed assets; and (iii) option-implied variance premiums for stocks have a U-shaped relation to skewness, amplified by volatility. We find strong empirical support for these predictions. Finally, we show that the -CAPM predicts an exaggerated co-movement of assets and can explain the correlation premium.

Keywords: G02; G11; G12 (search for similar items in EconPapers)
Date: 2025
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